Macro-Prudential Policies—an Asian Perspective

Good afternoon. It is a great pleasure to address this distinguished gathering, and to participate in the debate over the course of the day.

It is no accident that this conference is taking place in Asia. The ongoing transformation of the global economy, with Asia as an economic powerhouse, has been accelerated by the crisis. Today, Asia stands at the helm of the global recovery. Its policy choices are important for its own sake, and also for the global economy as a whole.

Looking ahead, fixing the fragilities in the global financial system is a key priority. This conference focuses on macro-prudential policies, which deal with the intersection of the real economy and the financial sector, providing a birds-eye view of the entire system. In our interconnected world, these policies will become increasingly important, both in shifting seamlessly out of the crisis and in moving toward new sources of growth.

Asia’s economic performance

Asia’s economic performance over the past few decades has been nothing short of remarkable. Driven by rapid and steady growth, the region now accounts for about a third of the global economy, up from under just a fifth in 1980. On current trends, Asia’s economy could be as large as the United States and the European Union—combined—by 2015.

Of course, growth must benefit everybody. And here, Asia has made tremendous progress with poverty reduction, with China alone pulling hundreds of millions of people out of poverty over the past few decades. Such a feat has never before been accomplished in the entire history of human civilization.

And when the global financial crisis hit, Asia proved remarkably resilient, bouncing back stronger and faster than elsewhere. Asia had not made the mistakes of other countries by piling up debt or using complex financial engineering that magnified risk. Banks had built sizeable capital cushions, followed prudent lending practices, and had limited exposure to toxic assets. Policymakers had internalized the lessons of the past, embracing sound macroeconomic and prudential policies.

Thanks to solid foundations and a quick and forceful policy response, Asia has become the launching pad of the global economic recovery. But this comes with challenges of its own.

The centrality of cooperation

Let me talk a little about cooperation. Cooperation is really the great legacy of this crisis, and is the main reason why the Great Recession did not become a second Great Depression.

This spirit of cooperation must be maintained. Without it, the recovery is in peril. Today, there is a risk that the single chorus that tamed the financial crisis will dissolve into a cacophony of discordant voices, as countries increasingly go it alone. This will surely make everybody worse off.

This is not a mantra. In a submission to the G20, the IMF showed exactly what could be accomplished by cooperative action on the part of the world’s major economies—boosting world growth by 2½ percentage points over five years, creating 30 million new jobs, and lifting 33 million people out of poverty. It’s a win-win outcome, and every country and region must play their part.

The great challenges of today all require a cooperative solution—especially if we are to achieve strong, sustainable, and balanced global growth in the years ahead. This is directly related to today’s conference. Future growth must be safer growth, less prone to financial excess and the buildup of macroeconomic imbalances. So financial sector and macro-prudential policies are like the glue that holds the system in place.

Financial sector reform

Let me talk a little bit about financial sector repair and reform. Before we talk about a new growth model, we need to fix old problems. We must make the financial sector safer and more stable, and put the banks back in the service of the real economy. Many of these problems emanate in the advanced countries beyond Asia, and these countries need to take the lead in fixing these problems.

We have a lot of unfinished business. Much progress has been made on the regulatory front, especially with the Basel III rules on the quantity and quality of bank capital. But these rules only apply to a subset of the financial system. Reforms must deal with risks in all financial institutions, not just banks—we learned this lesson the hard way during the crisis.

This is just regulation. There is still a lot to do on the other pillars of financial stability—supervision and crisis resolution. Rules are only as good as their implementation, and so supervision must be intensive and intrusive—not afraid of saying no to powerful interests. We also need coherent resolution mechanisms—both domestically and across borders—to allow failing firms to be wound down with minimal cost to taxpayers and to end the scourge of too-big or too-important to fail. Here, the IMF has proposed a financial stability contribution linked to a credible and effective resolution mechanism to pay for future bailouts. The cross-border issue is especially important, but vested interests remain strong. We have proposed a pragmatic cross-border coordination framework—this must be made operational among a small set of countries that are home to most cross-border institutions.

The macro-prudential angle

And then there is the macro-prudential dimension, the topic of the day. We all know that systemic risk is paramount. Looking to the safety and soundness of individual institutions is important, but we must not miss the big picture—how everything comes together to affect the stability and resilience of the financial system in its totality.

Amidst the rubble from the crisis, we need to build up a new macro-prudential framework. It is appropriate that this discussion takes place in Asia. Asia is leading the global recovery and is moving swiftly back toward normal policy conditions. Capital flows are flooding in. We do not want history to repeat itself in such a short time span. Asia also has a unique opportunity to lead by example.

Capital flows present a great opportunity for Asia, but also a great challenge. On one hand, we want capital to flow toward emerging markets. Channeled in the right direction—and guided by deepening domestic capital markets and effective supervision—capital flows can boost investment, growth, and living standards. But on the other hand, some flows can clearly be destabilizing. They can lead to exchange rate overshooting, credit booms, asset price bubbles, and financial instability.
So how should countries address these kinds of vulnerabilities? Since capital flows can reverse quickly in times of panic, it makes sense to have a financial safety net to complement macro-prudential policies. Regional financing arrangements—such as the Chiang Mai initiative—can play an important role here. The IMF is working to strengthen the global financial safety net, and stands ready to work with regional partners.

Dealing with crises is important, but it’s even better to prevent them. How can countries do this? I would first note that this is a pragmatic issue, not a matter of ideology. Countries have a number of policy options in their toolkits—lower interest rates, reserves accumulation, tighter fiscal policy, macro-prudential measures, and sometimes capital controls. The response should depend on circumstances—there is no one-size-fits-all solution. For example, with a credit-fueled housing bubble, prudential tools might be the way to go. If instead the problem is debt inflows fueling a boom in foreign currency lending to unhedged borrowers, then the solution might be different and might include capital controls. Again, we should always be pragmatic.

Clearly, conventional macroeconomic policies and macro-prudential tools are intrinsically linked, just as price stability and financial stability are intrinsically linked. We need a holistic approach, which means a changing role for central banks in the years ahead.

Conclusion

Let me try to sum up. This is a complex policy agenda, and will simply not succeed without cooperation. Without cooperation, the recovery is under threat and financial sector reform could be doomed to fail.

In all of this, the world is looking to Asia to play its part. Your time has come. Just as the 19th century belonged to Europe, and the United States dominated the 20th century, the 21st century can be the Asian century.

But with that comes great responsibility—to lead, to guide, and to take ownership of the collaborative agenda. Asia is now a major economic region, and being at the center means being responsible for the whole. Asia has an important voice in world affairs through the G20, and also through the IMF, which is in the process of giving more influence to dynamic emerging markets.

I will finish by saying that the IMF fully supports this agenda. The last time I was in Asia, in Korea, I said that the IMF can be an effective partner for Asia, and indeed, its second home. How can we do this? First, by better monitoring economic and financial risks, including with mandatory FSAPs for systemic countries, our early warning exercise, and our analysis of country spillovers. Second, by continuing to strengthen our crisis prevention and management frameworks, reducing the incentive to self-insure and supporting a global rebalancing. And third, by providing a forum for international policy cooperation, where 187 different countries are wedded a single goal—a prosperous world with rising living standards for all. Remember, we are all in this together.